Life insurance for retirees: For some it makes sense

You're retired. Your kids are self-sufficient and the house is paid off. There's no need to continue carrying life insurance, right?

For the most part, that's correct, said Bob Adams, a certified financial planner with Armstrong Retirement Planning. Life insurance is intended to replace lost income if the policyholder dies prematurely, he explained. If you're no longer working, there's no income to replace.

Before you let your policy lapse, however, it's important to consider your unique financial picture. There are plenty of exceptions for which continuing to pay those premiums into your 60s and beyond might make sense.

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"When I sit down with new retirees, we look at whether they need life insurance at all and how much their policy costs," he said, explaining that many people don't understand that their premiums may rise.

"We also look at whether they might be able to achieve what they want with a cheaper policy," he said. "You never want to cancel life insurance without analyzing those questions, because you can't usually recover your policy at the same rate again."

Indeed, premiums for life insurance coverage vary widely depending upon the type of policy you own.

Term life policies, the least expensive option, provide coverage for a specified duration, usually 10 to 30 years. A death benefit is paid to your heirs only if you die before the term expires. There is no savings component.

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Term life insurance can be purchased with either a level (fixed) or rising premium. Make sure you know what you're buying.

"Your rates can go up like a hockey stick," Adams said. "Most people don't understand what they sign up for and end up paying premiums for years, only to dump it when their rate gets too high."

He added, "The insurance companies laugh all the way to the bank because they collected all those years and never had to pay out a death benefit."

The other category of life insurance products is referred to as cash value, or permanent life. Such policies also pay out a death benefit to your heirs when you die, but they are far more expensive than term life.

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That's because, as the name implies, cash-value life insurance policies accumulate value over the policyholder's lifetime. Types of cash-value policies include whole life, universal life and variable life.

For most retirees, Adams recommends a guaranteed level-premium term life policy, in which the premiums remain constant, with just enough death benefit to cover a specific need.

Here are a few other reasons why an insurance policy would make sense:

For retirees who are still paying off large loans (think failed business ventures or real estate deals), a guaranteed level-premium term life policy is ideal, said Scott Simmonds, a fee-only insurance consultant in Saco, Maine.

But the key is not to overinsure. To minimize premium costs, he suggests considering a term life policy that expires when your payments are scheduled to end and to obtain just enough coverage to extinguish that debt.

"Life insurance in retirement might make sense if you have a fair amount of debt that you don't want to burden your family with," Simmonds said.

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Term life may also make sense if you continue to work during retirement, even part-time, to supplement your savings and wish to protect your spouse from the loss of your income when you die, he said.

It all depends on how much you earn and how much your savings falls short of your income needs. Generally speaking, though, you should cancel your policy immediately if your spouse—for whom the policy was intended to provide a financial cushion—dies before you, he said.

Parents of a disabled child who will need ongoing support such as medical care or assisted living, however, will need to purchase cash-value insurance, advised James Hunt, a life actuary for the Consumer Federation of America and founder of website Evaluatelifeinsurance.org. Coverage should be sufficient to pay for their child's projected expenses.

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Specifically, Hunt recommends a survivorship-whole life or -universal life policy, more commonly called a second-to-die policy, since it pays out to heirs only after both parents pass away.

You will also need the more costly cash value policy if you purchase life insurance for the purpose of leaving a charitable legacy, Simmonds said.

"Instead of making annual donations to your college of $10,000 a year, for example, you could buy life insurance worth $500,000 and pay the premiums with the equivalent of that annual donation," he said. "Many large charitable organizations are urging supporters to consider a gift of life insurance."

If structured correctly, Simmonds explained, the life insurance policy can benefit both you and the recipient of your gift.

Proceeds from a permanent life or cash-value policy can also be valuable as an immediate source of cash for your heirs, said Adams at Armstrong Retirement Planning. Such liquidity enables them to pay funeral expenses and federal and state estate/inheritance taxes without having to sell illiquid assets, such as property, the family business, depreciated stocks or jewelry.

If liquidity is your goal, a financial advisor can help you determine whether an irrevocable life insurance trust is best.

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With a properly drafted ILIT, you (the grantor) transfer all rights to the policy to the trust, and you cannot revoke, terminate or modify it going forward. The proceeds upon your death, though, avoid estate taxation and are sheltered from creditors.

An ILIT also has the advantages of removing the value of your life insurance policy from your estate and is especially useful if the grantor has children who are minors or who otherwise need financial protection.

Finally, there may be a case for maintaining cash-value life insurance as an investment if you're risk averse and affluent, said Hunt of the Consumer Federation of America. While banks are offering interest rates of 1 percent or less (taxable), many cash-value policies are currently offering tax-free growth of about 5 percent.

"If you have ample funds and are looking to get rid of a little every month, it would not be irrational to buy a whole-life, universal-life or variable-life policy, where the cash value grows income tax-free as long as the policy is held until death," Hunt said. "You can make the argument that because of its tax advantage, it makes sense to buy life insurance as an investment."

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It's worth noting that critics of cash-value insurance policies argue that investment choices are too limited and that investors could get a better return through a diversified portfolio of stocks.

For most retirees, life insurance is an unnecessary expense. But there are scenarios in which continuing coverage is prudent. Because it's a complex product, however, it's a good idea to consult a fee-only consultant for unbiased advice.